Near termed & mid termed view, and a case for small caps

Today, I am going to cover some thoughts to help you plan for the near and short termed time horizons.

Keith’s BNN appearance (Monday)

Here’s the link.

 

Small caps are looking better than large caps

Two reasons I like the look of the Russell 2000 Small Capped index (IWM ETF) chart below. Not necessarily a current buy, but something to watch.

  1. Fundamentals: The price-to-earnings ratios for large caps are much higher than that for small caps, which is not always the case. However, as a bear market matures, funds forced to invest will stay by the large caps. Why? Because they know they will get redemptions and need to sell. Therefore, they will only buy liquid (and thus large) names. The liquidity premium is quite high in mature bear markets. But that won’t last forever–because the bear will end. IWM is already the better place to spot value.
  2. Technical’s: Note the support coming in at the exact same highly significant level of resistance (now support) that lasted from 2018-2020. Note the lack of a lower low this summer, vs. the SPX chart below. Note the rising momentum oscillators. CFM, RSI, MACD. Note the red comparative strongth vs the SPX is also rising (aka the small caps are outperforming the SPX).

 

 

Here’s the SPX large capped index for comparison: Note that long termed support lies waaaaayyyy down below the last low. I’m thinking 3200-ish. Also note the lower low in the summer – aka the downtrend is not showing signs of a base. Positive CFM (top pane), but all of the other oscillators are flat vs. up on the IWM chart. Bottom pane cumulative moneyflow is the same (flat) for both indices so far.

All in, I’m thinking that IWM will be a better bet when the bear market is over.

Put to call ratio may signal neartermed rally

The 30-day moving average of the equity put/call ratio has risen to the highest since November 2008.

A lot of funds are buying puts according to BearTraps research. From a contrarian viewpoint, too many puts vs calls trading looks like excess hedging, with money managers and investors in panic mode buying “insurance” on year-end. I’ve circled the recent spikes in put buying on the chart below. I look for clusters–most certainly has been a bit of panic hedging lately, don’t ya think?

Seasonality averages suggest a rally

The SPX is off 6% in December 2000 vs +90bps average return since 2000. So this hasn’t been your normal December from a seasonal pattern perspective. Since 2000, there have been only 3 negative years more than 5% notable decline in December. This, like my put/call ratio observation, speaks to upside potential as volume fades out heading into year-end. I’m talking short termed rally here folks. Get out or rotate to better sectors if/as/when opportunities might present themselves.

Short termed rally aside…Bull & Bear market durations- suggesting more downside

Take a look at the chart below. Here’s something to make you pucker: We are roughly 12 months into a bear market which is still well below the 20 month average length and … wait for it…also below the average drawdown of -41%.

 

 

Why a recession is becoming more likely

Hey don’t listen to me about economics. I’m just a simple Technical Analyst (although in 2020 & 2021 ValueTrend called the inflation longevity better than the largest government financial influencer in the entire world. The US Federal Reserve Chair…just sayin’…).

Powell: The last two CPI reports show “a welcome reduction in the monthly pace of price increases. It will take substantially more evidence to have confidence that inflation is on a sustained downward path. We are going into higher inflation next year than we thought. Recent data gives US greater confidence in our forecasts… We have a ways to go on core services ex housing. Inflation in non-housing services is fundamentally about the labor market and wages. See little progress in average hourly earnings coming down. There is no painless way to restore price stability. I wish there were a painless way to restore price stability; there isn’t.”

Bill Ackman: “I don’t think the Federal Reserve can get inflation back to 2% without a deep, job-destroying recession. Even if it gets back to 2%, it won’t remain stable there for the long term. Accepting 3%+/- inflation is a better strategy for a strong economy and job growth over the LT.”

 

Similar thoughts were echoed during my Maxime Bernier interview here: Special guest interview! – ValueTrend

Inverted yield curve strongest since 1962…

I was born in the summer of 1962. I’m 60 –  feeling like I’m only 59 (grin!). And no – not retiring for a long time. Too much fun, this stuff!

Anyhow–Here’s Bespoke on comparing the yield curve today to that year, oh so long ago–I’ve made the important part of their observations bold:

“Going back to 1962, there have been four other periods where the 3m10y curve inverted by 50 bps or more for at least 15 straight trading days.  Each of those prior streaks lasted much longer than the current streak, although, with the curve inverted by over 80 bps, this streak can also be expected to last much longer.  In terms of where these streaks occurred in the business cycle, in each of the four periods, a recession followed within eight months.” Bespoke

For those unfamiliar with the yield curve. Basically, the “normal” situation is for longer commitments (long bonds) to yield more than short commitments.  An inverted yield curve occurs when yields on short-term bonds rise above the yields on longer-term bonds of the same credit quality, which has proven to be a relatively reliable indicator of an economic recession. The chart below shows you that 1 year bonds pay more than 30 year bonds! This screams “recession”. For equity investors, this means that the market may also have a final leg down to go.

 

Conclusion

I think that the market has a decent chance of a short termed rally. Thereafter, the market looks like it might continue its downward trajectory for a while. Possibly for a final bear market washout (lower low) as recession talk becomes more predominant. I’ve hammered into your cranial vaults the idea that financial assets will likely be on the back-foot as governments acknowledge that 2% inflation targets are unrealistic, the USD is too high, and recession isn’t just just talk. Its real. The alternative to financial assets is inflation protective assets like commodities and commodity producers, gold, emerging markets, and global currencies. Those, and unique overlooked value plays – like the small capped arena as I discussed above. I’ll continue to post my thoughts.

6 Comments

  • Hi Keith, if we get some sort of Santa rally, will you be using the opportunity to raise more cash or would you go hide out in commodities, commodity producers, etc. Also, what is your current % cash position, and, if you think the market will slide from here, what would you increase it to?

    Reply
    • Mark–we are 30% cash and will remain so until the SPX crosses the 200 day SMA and stays there for several days–see my Online Technical Analysis course for my step-by-step process on legging into a position. In the meantime, we have already begun to slowly rotate back into commodities- some as direct plays on the commodity (ETF’s) and some in producers. This means that we are selling other positions to move into commodities, but not a rush. We have mostly been in staples and value all year–which I’ve informed everyone on the blog of (pounding the table, actually) since Q1 2022. I’m thinking the real rotation into hard assets will start in earnest in the next month or two, although we are seeing some strength setting in the hard assets already= gold and silver in particular.

      Reply
  • Hi Keith,
    RE: Inflation Protective Assets
    Do Real Return Bonds/T-Bills qualify?
    I believe I recently read that these fixed-income instruments are being phased out? Not much trading volume.

    Reply
    • Hard to say Ross. XRB did ok on a relative basis in 2022, but I am not sure how they might perform as inflation stops rising, declines and settles in at my suggested 3-4% range.

      Reply
  • Hi Keith.
    I hope you are enjoying a holiday and wishing you and your family a healthy and happy New Year. This is my first time ever responding online. I am not on any social media. I enjoyed your show on BNN and have enjoyed all of your previous ones. I have for many many years listened, talked to Leon Tuey up until his unfortunate death this year. Did you know him ? He was so smart and so funny and a great friend. Since then, I have been searching for a new technical analysis guru and I think you are it. I will continue to read your articles and will follow you for your insight. Thanks. Eric

    Reply
    • Thanks Eric–I didn’t know Leon, although knew of him. Yes, a real contributor to the field. Too young. This coming year is, like last year, one for technical analysis and buy/sell/rotation. Buy/hold will be hard to make money in until the bear ends–and that may not happen for at least the first part of the year.

      Reply

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